How Are Non-Grantor Irrevocable Trusts Taxed?
Non-grantor trust taxation
Question:
How is different income taxed in non-grantor trusts? For example, are capital gains taxed as income or at capital gains rates? Interest? Dividends? What is taxed and then considered part of the corpus?
Response:
Non-grantor trusts are irrevocable since all revocable trusts are grantor trusts by definition. Irrevocable trusts are considered grantor trusts if their provisions result in all income being taxed to the grantor. However, most irrevocable trusts are considered non-grantor trusts with the income taxed to the trust unless it is distributed to a beneficiary, in which case it passes through to that beneficiary. In that case, the trust deducts the income on its 1041 tax return and issues a K-1, similar to a 1099, to the beneficiary reporting the taxable income attributable to them.
However, there is a distinction between capital gains and other income, such as dividends and interest. While dividends and interest will pass through to beneficiaries as I just described, capital gains are always taxed to the trust.
To the extent income remains in the trust, it is taxed just as it is for individuals. The only difference is that rates accelerate much more quickly for trusts than for individuals, with trusts reaching the top 37% income tax rate after just $15,200 of income (in 2024) and the top capital gains rate of 20% on just $14,650 (in 2024) of gain. Given that most trusts do make distributions to beneficiaries, few actually end up paying the higher income tax rates.
Your last question appears to ask when income becomes part of the corpus of the trust. While traditionally many trusts kept separate accounts for income and principal, that is unusual today. All income becomes part of the trust corpus as soon as it is received.
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